Here's Why Kuala Lumpur Kepong Berhad (KLSE:KLK) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kuala Lumpur Kepong Berhad (KLSE:KLK) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kuala Lumpur Kepong Berhad

What Is Kuala Lumpur Kepong Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Kuala Lumpur Kepong Berhad had RM10.8b of debt, an increase on RM9.38b, over one year. However, it also had RM2.67b in cash, and so its net debt is RM8.12b.

How Strong Is Kuala Lumpur Kepong Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kuala Lumpur Kepong Berhad had liabilities of RM5.46b due within 12 months and liabilities of RM9.43b due beyond that. Offsetting these obligations, it had cash of RM2.67b as well as receivables valued at RM3.61b due within 12 months. So it has liabilities totalling RM8.61b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Kuala Lumpur Kepong Berhad has a market capitalization of RM22.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kuala Lumpur Kepong Berhad's debt is 3.4 times its EBITDA, and its EBIT cover its interest expense 3.3 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Even worse, Kuala Lumpur Kepong Berhad saw its EBIT tank 50% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kuala Lumpur Kepong Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Kuala Lumpur Kepong Berhad's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Kuala Lumpur Kepong Berhad's EBIT growth rate was disappointing. But at least its level of total liabilities is not so bad. Overall, we think it's fair to say that Kuala Lumpur Kepong Berhad has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Kuala Lumpur Kepong Berhad (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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